An “out-of-the-money” option is worthless to a buyer if it expires.
A call option is “out-of-the-money” when the market price of the underlying security is below the strike price. A put option is “out-of-the-money” when the market price of the underlying security is above the strike price.
It is important to understand that an “out-of-the-money” option has value if time remains before its expiration date. However, if the option expires “out-of-the-money,” then it becomes worthless and the buyer of the option will lose the premium he paid to acquire it.
“Out-of-the-money” options are cheaper to buy than “in-the-money” options. However, an option buyer only wants to obtain an “out-of-the-money” option if he expects to end up “in-the-money.”
Let’s look at a couple examples of what it means to be “out-of-the-money.”
- Intel Corporation (NYSE: INTC) has a price per share of $50. Imagine an investor buying one call option for INTC with a strike price of $53 that expires in one month. In that one month, the market price of INTC stays at $50. It never closes at, or above, $53. This means that the option is “out-of-the-money.” The option expires worthless. The option buyer paid a premium to the option writer for the call option of $1 per share. So, the option buyer lost $1 per share from the call option because it expired “out-of-the-money.”
- Intel Corporation (NYSE: INTC) has a price per share of $50. Suppose an investor buys a put option for INTC with a strike price of $47 that expires in one month. In that one month, the market price of INTC stays at $50. It never closes at, or below, $47. This means that the option is “out-of-the-money.” The option expires worthless. The option buyer loses the $1 per share he paid in premium to the option writer for the put option that expires “out-of-the-money.”
These examples should show how “out-of-the-money” options are risky for investors, since they can cause a loss upon expiration.
